Supply Tax Cuts and the Truth About the Reagan Economic Record

by William A. Niskanen and Stephen Moore

William A. Niskanen is chairman and Stephen Moore is director of fiscal policy studies at the Cato Institute.

Executive Summary

Bob Dole's proposal for a 15 percent income tax cut has reignited the long-standing debate about the economic impact of Reaganomics in the 1980s. This study assesses the Reagan supply-side policies by comparing the nation's economic performance in the Reagan years (1981-89) with its performance in the immediately preceding Ford-Carter years (1974-81) and in the Bush-Clinton years that followed (1989-95).

On 8 of the 10 key economic variables examined, the American economy performed better during the Reagan years than during the pre- and post-Reagan years.

Real economic growth averaged 3.2 percent during the Reagan years versus 2.8 percent during the Ford-Carter years and 2.1 percent during the Bush-Clinton years.

Real median family income grew by $4,000 during the Reagan period after experiencing no growth in the pre-Reagan years; it experienced a loss of almost $1,500 in the post-Reagan years.

Interest rates, inflation, and unemployment fell faster under Reagan than they did immediately before or after his presidency.

The only economic variable that was worse in the Reagan period than in both the pre- and post-Reagan years was the savings rate, which fell rapidly in the 1980s. The productivity rate was higher in the pre-Reagan years but much lower in the post-Reagan years.

This study also exposes 12 fables of Reaganomics, such as that the rich got richer and the poor got poorer, the Reagan tax cuts caused the deficit to explode, and Bill Clinton's economic record has been better than Reagan's.

Introduction

Bob Dole's call for a 15 percent across-the-board income tax cut has provoked yet another fierce debate about
the Reagan economic record. Because Dole's tax plan is at least partly modeled after Reagan's tax cuts of 1981,
the Reagan record has recently been put squarely back on trial. [1]

Judging from the partisan political discourse in Washington, there is virtually no agreement about what that record
tells us. Republicans describe the 1980s as an era of prosperity--a decade when America reasserted its economic
and military might. Democrats, on the other hand, portray the Reagan presidency as a period of record budget
deficits, economic decline, and widening income gaps between rich and poor. Senator Bill Bradley (D-N.J.)
recently described the 1980s as a decade of "discredited supply side economics." President Clinton recently
warned that, like the Reagan tax cuts, the Dole tax cut would "balloon the deficit, raise interest rates, and weaken
the economy." [2]

Often partisanship and ideology prevent a dispassionate assessment of the Reagan years. The political left has
adopted the convention of arguing that the beneficial economic changes in the 1980s--the conquering of inflation,
the surge in employment, and the sustained economic expansion--had little to do with Reagan's policies, whereas
any negative change--the explosion in the budget deficit, the savings and loan crisis, and so forth--was a direct
consequence of the failed theology of Reaganomics. [3] Meanwhile, the right argues that only the triumphs of
Reagan's record deserve much attention, and that any blemishes--again the big budget deficits--were
inconsequential or the fault of the Democrats in Congress. [4]

This study attempts to cut through the fog created by this partisan dialogue and spotlight the real economic record
of the 1980s--sticking to "just the facts." All the figures provided in this study come from standard statistical
sources: Bureau of the Census, the Economic Report of the President, and Historical Tables, Budget of the U.S.
Government. To judge how well the economy performed under Reagan's policies, we compare the economic
performance of the Reagan years (1981-89) with that of the immediate pre-Reagan years (1974-81) and the
post-Reagan years (1989-95).

In the last part of the study we provide some interpretation of these economic and fiscal data and sort out fact from
fable regarding the 1980s. We also examine the implications of the economic data as they relate to the advisability
of an income tax rate cut in 1997.

The Era of Reaganomics

In 1981 Ronald Reagan entered the White House and immediately implemented a dramatic new economic policy
agenda for the country that was dubbed "Reaganomics." [5]Reaganomics consisted of four key elements to reverse
the high-inflation, slow-growth economic record of the 1970s: (1) a restrictive monetary policy designed to stabilize
the value of the dollar and end runaway inflation; (2) a 25 percent across-the-board tax cut enacted (The
Economic Recovery Tax Act of 1981) designed to spur savings, investment, work, and economic efficiency; (3) a
promise to balance the budget through domestic spending restraint; and (4) an agenda to roll back government
regulation.

Clearly, some of those goals were accomplished; others were not. The most objective way to assess whether the
policies were a success is to examine the economic evidence for the Reagan years once the policies were
implemented.

A Model for Assessing the Reagan Record

There is some disagreement about what date should be used to measure the economic starting point of the Reagan
era. A common ploy of Reagan's critics is to measure the economy's performance from 1979 to 1989 and falsely
describe the record over this period as "the Reagan years." For example, in 1991 the Democrats on the Joint
Economic Committee of Congress released a report entitled "Falling Behind: The Growing Income Gap in
America," which purportedly proves that the victims of Reaganomics were the least affluent Americans. The report
concluded that "families in the lowest forty percent of the income distribution actually had lower real incomes on
average in 1989 than they did in 1979." Upon closer inspection, however, what the income data really show is that
when Jimmy Carter's economic policies were in effect, family incomes plummeted by 9 percent, but that after
Reagan's economic policies took effect (1982-89), family incomes rose by 11 percent. In the Joint Economic
Committee report, Reaganomics is blamed for the poor performance of the economy under Carter. Ronald Reagan
had many seemingly magical qualities, but his policies were never able to influence the economic direction of the
nation at least two years before they took effect. Some of Reagan's supporters, on the other hand, define the
Reagan years as only the seven years of economic expansion, 1983-89, while conveniently omitting the recession
years of 1981 and 1982. [6]

There are two defensible methods of measuring the performance of the economy on Reagan's watch. One method
is to examine the economic record from the month Reagan formally took office, January 1981, through the month
he left the White House, January 1989.

An alternative approach is to allow a one-year lag for the policy changes to be enacted and take effect on the
economy. Reagan's tax cuts were not even passed by Congress until midsummer of 1981 and did not begin to take
effect until October 1, 1981. His first budget proposal was for fiscal year 1982. Hence, if we define the beginning
of the Reagan years as the first full year when the policies were in effect, the eight years in which Reagan's policies
were in effect were 1982-89. This latter approach seems to provide a more accurate gauge of the economy's
reaction to the change in policies Reagan enacted in 1981, and for this reason we adopt this as the standard for
analysis in this study--that is, we measure the economic effects of Reagan policies beginning with January 1982 and
using 1981 as the base year of comparison. (This still picks up the deep recession of the early 1980s.) For those
who are unsatisfied with this method of measuring the Reagan record, in Table 1 we present the data both ways:
first, from the month Reagan entered office through the month he left office, and second, with a one-year lag to
adjust for the timing of the policy changes. The results do not differ substantially regardless of which dates are used.

Just as controversial is the issue of when the Reagan era ended. Again, Reagan's political foes often describe the
entire 12 years of the Reagan and Bush administrations as the "Reagan years." [7]At first blush this seems logical:
two Republican administrations in succession would normally suggest a continuation of policy from one to the
other. Yet the real and dramatic shift in economic policy in Washington occurred not in 1993, with the start of the
Clinton administration, but rather in 1990, with George Bush's repudiation of his "no new taxes" pledge that led to
both the enactment of a large anti-supply-side tax increase and a flurry of legislation--from the Clean Air Act
amendments, to the Civil Rights Act of 1991, to the Americans with Disabilities Act--that began the reregulation of
America in the 1990s. [8] Indeed, the Clinton economic program in most respects has been closest to that of
George Bush, particularly with respect to the direction of fiscal policy.

In sum, we delineate two years as marking turning points in economic policy in the United States: 1981 and 1990.
Because these two years represent dramatic policy shifts, they provide a convenient and unique laboratory-like
testing ground for assessing the success or failure of Reaganomics. In this study we compare the economic
performance in the pre-Reagan years (1974-81), the Reagan years (1981-89), and the post-Reagan years
(1989-95). [9]

For fiscal variables examined at the end of this report, there is much less controversy over the start and the end of
the Reagan presidency. Reagan's first budget was for fiscal 1982 (not 1981), and his last budget was for fiscal
1989. [10]

The Real Reagan Economic Record

Table 1 contrasts side by side the economy's performance for the three periods of analysis--1974-81, 1981-89,
and 1989-95--for 10 key variables. We measure the change in each economic variable from the start of the period
through the end and present the annualized change. [11] On 8 of the 10 key variables, the Reagan record
unambiguously outperformed the records of the pre- and post-Reagan years. The two exceptions were the savings
rate, which declined in the Reagan years at a faster rate than in the pre- and post-Reagan years, and productivity,
which grew faster in the pre-Reagan years but slower in the post-Reagan years. [12] The following is a summary for
each of the 10 variables:

Economic Growth. The average annual growth rate of real gross domestic product (GDP) from 1981 to
1989 was 3.2 percent per year, compared with 2.8 percent from 1974 to 1981 and 2.1 percent from 1989
to 1995. The 3.2 percent growth rate for the Reagan years includes the recession of the early 1980s, which
was a side effect of reversing Carter's high-inflation policies, and the seven expansion years, 1983-89.
During the economic expansion alone, the economy grew by a robust annual rate of 3.8 percent. By the end
of the Reagan years, the American economy was almost one-third larger than it was when they began. [13]
Figure 1 shows the economic growth rate by president since World War II. That rate was higher in the
1980s than in the 1950s and 1970s but was substantially lower than the rapid economic growth rate of more
than 4 percent per year in the 1960s. The Kennedy income tax rate cuts of 30 percent that were enacted in
1964 generated several years of 5 percent annual real growth.

Economic Growth per Working-Age Adult. When we adjust the economic growth rates to take account of
demographic changes, we find that the expansion in the Reagan years looks even better and that the 1970s'
performance looks worse. GDP growth per adult aged 20-64 in the Reagan years grew twice as rapidly, on
average, as it did in the pre- and post-Reagan years.

Median Household Incomes. Real median household income rose by $4,000 in the Reagan years--from
$37,868 in 1981 to $42,049 in 1989, as shown in Figure 2. This improvement was a stark reversal of the
income trends in the late 1970s and the 1990s: median family income was unchanged in the eight
pre-Reagan years, and incomes have fallen by $1,438 in the anti-supply-side 1990s, following the 1990 and
1993 tax hikes. [14] Most of the declines in take-home pay occurred on George Bush's watch. Under Bill
Clinton's tenure, there has been zero income growth in median household income.

Employment. From 1981 through 1989 the U.S. economy produced 17 million new jobs, or roughly 2
million new jobs each year. Contrary to the Clinton administration's claims of vast job gains in the 1990s, the
United States has averaged only 1.3 million new jobs per year in the post-Reagan years. The labor force
United States has averaged only 1.3 million new jobs expanded by 1.7 percent per year between 1981 and
1989, but by just 1.2 percent per year between 1990 and 1995. [15]

Hours Worked. Table 1 confirms that hours worked per adult aged 20-64 grew much faster in the 1980s
than in the pre -or post-Reagan years.

Unemployment Rate. When Reagan took office in 1981, the unemployment rate was 7.6 percent. In the
recession of 1981-82, that rate peaked at 9.7 percent, but it fell continuously for the next seven years.
When Reagan left office, the unemployment rate was 5.5 percent. This reduction in joblessness was a clear
triumph of the Reagan program. Figure 3 shows that in the pre-Reagan years, the unemployment rate
trended upward; in the Reagan years, the unemployment rate trended downward; and in the post-Reagan
years, the unemployment rate has fluctuated up and down but today remains virtually unchanged from the
1989 rate.

Productivity. For real wages to rise, productivity must rise. Over the past 30 years there has been a secular
downward trend in U.S. productivity growth. Under Reagan, productivity grew at a 1.5 percent annual rate,
as shown in Figure 4. This was lower than in the 1950s, 1960s, and 1970s but much higher than in the
post-Reagan years. Under Clinton, productivity has increased at an annual rate of just 0.3 percent per
year--the worst presidential performance since that of Herbert Hoover.

Inflation. The central economic evil that Ronald Reagan inherited in 1981 from Jimmy Carter was three
years of double-digit inflation. In 1980 the consumer price index (CPI) rose to 13.5 percent. By Reagan's
second year in office, the inflation rate fell by more than half to 6.2 percent. In 1988, Reagan's last year in
office, the CPI had fallen to 4.1 percent. Figure 5 shows the inflation and interest rate trend.

Interest Rates. In 1980 the interest rate on a 30-year mortgage was 15 percent; this rate rose to its all-time
peak of 18.9 percent in 1981. The prime rate steadily fell over the subsequent six years to a low of 8.2
percent in 1987 as the inflationary expectation component of interest rates fell sharply. The prime rate hit its
20-year low in 1993 at 6.0 percent. The Treasury Bill rate also fell dramatically in the 1980s--from 14
percent in 1981 to 7 percent in 1988. In the 1990s, interest rates have continued to migrate gradually
downward, as shown in Figure 5.

Savings. The savings rate did not rise in the 1980s, as supply-side advocates had predicted. In fact, in the
1980s the personal savings rate fell from 8 percent to 6.5 percent. [16]In the 1990s the average savings rate
has fallen even further to an average of 4.9 percent [17]--although the rate of decline has slowed.

The decline in the personal savings rate in the 1980s was disappointing, but two factors mitigate the implications of
these statistics. First, the drop in the savings rate was partly a natural response to demographic changes in
America--namely, the baby boomers entering their peak spending years. Second, the savings rate data fail to
account for real gains in wealth, which clearly are an important form of savings. The real value of capital assets and
property doubled from 1980 to 1990. The Dow Jones Industrial Average nearly tripled from a low of 884 in 1982
to 2,509 in 1989. These increases in the value of stocks, bonds, homes, businesses, and so forth added to
Americans' balance sheets hundreds of billions of dollars of wealth that are not accounted for in the savings rate
statistics. [18]

Total civilian employment, per member of the adultworking-age population*

0.3

0.5

0.2

0.2

0.7

0.1

Total hours worked, business sector, per member of the adult working-age
population*

-0.5

0.5

0.2

-0.5

0.8

0.0

Productivity (business sector output per hour)

1.2

1.5

1.1

1.6

1.3

1.1

Annual Percentage Point Change

Unemployment rate

0.3

-0.2

0.0

0.2

-0.3

0.0

Inflation rate (change in GDP chain-type price index)

0.4

-0.8

-0.2

-0.2

-0.5

-0.3

Long-term interest rate (corporate bonds, Moodys Aaa)

0.6

-0.3

-0.3

0.8

-0.6

-0.3

Personal savings rate

-0.2

-0.4

0.0

0.0

-0.5

-0.1

Source: Cato Institute calculations, based on data from Economic Report
of the President, 1996; and Department of Commerce.
*Figures were divided by the working-age adult population (defined as those
aged 20-64).

The Reagan Fiscal Record

The fiscal record of the 1980s was much less impressive than the economic record. The major outcomes of
Reagan's budgetary policies, as well as of the pre- and post-Reagan budgetary policies, are summarized in Table
2. Highlights are as follows:

Budget Deficit. The budget deficit exploded in the 1980s. Figure 6 shows that in 1981, the budget deficit
was $101 billion (in 1987 dollars) and 2.7 percent of GDP. In 1983 it peaked at $236 billion and 6.3
percent of GDP. By the time Reagan left office in 1989, however, it had fallen to $141 billion and 2.9
percent of GDP. These deficits were higher in real dollars than those under any other post-World War II
president except for George Bush.

National Debt. The national debt (public debt) in real 1987 dollars doubled from $1,004 billion in 1981 to
$2,028 billion in 1989. As a share of GDP, the debt increased from 27 percent to 42 percent, as shown in
Figure 7. In the 1990s the debt has risen to 52 percent of GDP. The rise in the national debt in the 1980s
was large and has imposed significant repayment costs on future generations.

Total Revenue Growth. Nominal federal revenues dou-bled in the 1980s from $517 billion to $1.031 trillion.
From 1981 to 1989 real federal revenues climbed by 20 percent. As a share of GDP, however, federal tax
revenues fell by 1.0 percentage point during that period.

Income Tax Receipts. Even income tax revenues grew substantially in the 1980s. In 1981 income tax
receipts totaled $347 billion; in 1989 they totaled $549 billion, a 58 percent increase. In fact, income tax
collections grew only slightly slower in the 1980s than in the 1990s despite income tax rate reductions in the
Reagan years and increases in the Bush-Clinton years. Real income tax revenues rose by 16.3 percent from
1982 to 1989 after the top income tax rate had been reduced from 70 percent to 50 percent in 1983, and
then to 28 percent in 1986. According to the latest (August 1996) Congressional Budget Office (CBO)
forecast, real income tax revenues will have grown by 17.9 percent from 1990 to 1997, following the raising
of the top income tax rate from 28 percent to 31 percent in 1990 and then to 39.6 percent in 1993. [19] On
a purely static basis, the 1990 tax increase raised $380 billion less in income tax revenues from 1991 to
1995 than had been predicted. [20]

Federal Spending. The federal budget was not cut under Reagan. In fact, it was 69 percent larger when
Reagan left office than when he entered it--22 percent larger in real terms. As a share of GDP, federal
outlays declined by less than 1 percentage point. [21]

Defense Spending. From 1981 to 1989, the Pentagon budget doubled from $158 billion to $304 billion.
The years of the greatest spending hike in the military budget were 1978-87, when the Pentagon's
expenditures rose from $180 billion to $280 billion in real 1987 dollars.[22]

Domestic Spending. Overall domestic spending growth was relatively constrained during the Reagan
presidency, particularly compared with that of other presidencies, as shown in Table 3. In fact, domestic
spending grew at a slower real rate under Reagan than under all other recent presidents. Moreover,
domestic outlays as a share of GDP fell from 15.3 to 12.9 percent from 1981 to 1989 (Table 2). But the
reductions in domestic spending were substantially smaller than required to balance the federal budget, cut
taxes, and finance a military build-up.

Table 2
Budget Trends before, during, and after the Reagan Years

Percentage Change

Pre-Reagan

Reagan

Post-Reagan

FY1973

FY1981

FY1989

FY1996

1973-81

1981-89

1989-96

Billions of 1987 Dollars

Total outlays

620.3

867.7

1,057.2

1,170.5

39.9

21.8

10.7

Defense

197.2

198.2

285.9

197.0

0.5

44.2

-31.1

Domestic

380.0

581.1

615.0

790.0

52.9

5.8

28.5

Interest

43.1

88.4

156.3

183.5

105.1

76.8

17.4

Receipts

582.7

766.6

916.2

1,062.1

31.6

19.5

15.9

Individual income tax revenue

260.7

365.8

412.2

469.6

40.3

12.7

13.9

Deficit

37.6

101.0

141.0

108.4

168.6

39.6

-23.1

Debt held by the public

860.7

1,004.7

2,025.2

2,805.4

16.7

101.6

38.5

GDP (chain-weighted 1992 $)*

3,902.3

4,724.9

6,060.4

6,742.9

21.1

28.3

11.3

Percentage of GDP

Total outlays

19.3

22.9

22.1

21.4

3.6

-0.8

-0.7

Defense

6.0

5.3

5.9

3.6

-0.7

0.6

-2.3

Domestic

11.9

15.3

12.9

14.5

3.4

-2.4

1.6

Interest

1.4

2.3

3.3

3.3

0.9

1.0

0.0

Receipts

18.1

20.2

19.2

19.4

2.1

-1.0

0.2

Individual income tax revenue

8.1

9.6

8.6

8.6

1.5

-1.0

0.0

Deficit

1.2

2.7

2.9

2.0

1.5

0.2

-0.9

Debt held by the public

26.8

26.5

42.3

51.4

-0.3

15.8

9.1

Table 3
Growth of Domestic Spending, by President

Annual Percentage
Annual Increase in Billions

President Increase
of 1995 dollars

Truman

5.5

5

Eisenhower

7.5

12

Kennedy/Johnson

8.0

21

Nixon/Ford

8.5

42

Carter

3.5

34

Reagan

1.0

17

Bush

4.5*

29

Clinton

3.0*

23

Source: Historical Tables, Budget of the United States Government, Fiscal Year 1996.

*Includes nondefense spending in the defense budget.

The 1980s: Facts versus Fables

In this section we depart from the purely factual presentation of the economic and fiscal performance of the 1980s
presented above and interpret what these data say about the Reagan years. We find in many cases that the
historical evidence contradicts much of the most commonly cited conventional wisdom of the Reagan years.
Specifically, there are 12 common fables about the 1980s that are at odds with the facts.

Supply-siders predicted their tax cuts would pay for themselves. This was nonsense from day one, because the
credible evidence overwhelmingly indicates that revenue feedbacks from tax cuts is 35 cents per dollar, at most.
Are we really gullible enough to accept a free dinner while still suffering the indigestion from our "free" lunch? [23]

This is one of the great enduring myths of Reaganomics: that the White House relied on wild supply-side
assumptions regarding the revenue impact of the tax cuts. The Reagan administration never assumed that the tax
cuts would pay for themselves. In fact, "America's New Beginning: A Program for Economic Recovery," the White
House budget plan released on February 18, 1981, included a table entitled "Direct Revenue Effects of Proposed
Tax Reductions." [24] That table predicted a huge $700 billion revenue loss from the tax cuts through 1986, as
shown in Table 4.

Source: Office of the President, "America's New Beginning: A Program for Economic Recovery," February 18, 1981, p. 16.

Fable 2: The Reagan Tax Cuts "Caused" the Budget Deficit to Explode in the 1980s

Fifteen years ago, marginal tax rates and the progressivity of the tax system were dramatically reduced. Some
suggested that these policies would so spur economic growth that tax revenue would actually increase. The
outcome of that experiment is now a matter of record: not only did this response not occur, but the national debt
quadrupled in the span of a dozen years. [25]

This is the most common and overly simplistic interpretation of the budgetary events of the 1980s. Further, it is
factually untrue that the Reagan tax cuts were a major cause of the budget deficits of the 1980s and the
"quadrupling" of the debt. (In the 1980s the real debt doubled; it did not quadruple.) Real federal revenues grew at
a faster pace after the Reagan tax cuts than after the Bush and Clinton tax hikes. From 1982 to 1989, they
expanded by 24.1 percent. Over a comparable seven-year period, 1990-97, a period that accounts for both the
Bush and the Clinton tax increases, real federal revenues will have grown by 19.3 percent (see Table 5). The
lesson of the 1980s and 1990s is consistent with the supply-side theory that there are behavioral and investment
responses to changes in tax rates.

Figure 8 shows that, as a share of GDP, federal revenues fell from 20.2 percent in 1981 (the peak year for taxes
as a share of GDP in the post-World War II period) to a low of 18.0 percent of GDP in 1984, and rose back up
to 19.2 percent by 1989. This would suggest that the Reagan tax cuts were a small contributing factor to the
increase in the budget deficit over the course of the 1980s. From 1950 to 1995, federal receipts have averaged
18.4 percent of GDP. Hence, throughout most of the Reagan years and clearly by the end, taxes as a share of
national output were substantially above the postwar average.

If the Reagan tax cut was not the major contributing factor to the increasing deficit in the 1980s, what was? There
were two primary explanations: (1) a large and sustained defense build-up; and (2) the unexpected rapid decline in
inflation and the recession in the early 1980s.

The Defense Buildup and the Deficit. Table 6 shows that the cumulative increase in defense spending from 1981 to
1989 ($806 billion) was larger than the entire cumulative increase in the budget deficit ($779 billion) in those years.
That is, if defense spending had been held to the rate of inflation from 1981 to 1989, the total real deficit would
have fallen in the 1980s rather than risen. It is also true that the decline in the military budget accounts for almost
the entire fall in the deficit from 1988 to 1996. [26]

Source: Historical Tables, Budget of the United States Government, Fiscal Year 1997.

If the entire accumulation of debt in the 1980s went to finance the Reagan defense build-up, the key policy
question would shift to whether it was appropriate to borrow for those large military expenditures. Was the Reagan
administration justified in paying for this one-time increase in "public investment" spending through debt rather than
taxes? Or, put another way, was it appropriate to have asked our children and grandchildren to help defray the
cost of defeating the Soviet menace?

The answer to that question rests to some extent on the issue of whether the defense build-up materially
contributed to the collapse of the Soviet Union and, if so, on the discounted present value to our children and
grandchildren of no longer having the "Evil Empire" imperiling the security of the planet. The figure could easily be in
the trillions of dollars.

In any case, Reagan's critics were proven right when they said that the administration would not be able to cut tax
rates, increase the defense budget, and balance the budget all at the same time.

The Fall in Inflation and the 1981-82 Recession. The unexpectedly steep decline in inflation in 1981 and 1982
contributed significantly to the rise in the deficit in the early 1980s. [27] When inflation falls sharply and
unexpectedly, so too do nominal revenues while real expenditures rise sharply and unexpectedly. Both Reagan and
Congress had approved spending increases for 1982-85 on the assumption, mostly due to erroneous inflation
forecasts, that nominal GDP would be some $2.5 trillion higher than it was between 1981 and 1986. The abrupt
reduction in inflation created an estimated $300-$400 billion spending windfall for defense and domestic programs.
[28]

Fable 3: The Federal Reserve, Not Ronald Reagan, Deserves the Credit for Ending the 1970s Era of
High Inflation

One man is more responsible for the political success of the Reagan presidency than any other, and
his name is not Ronald Reagan. It is Paul Volcker, the man Jimmy Carter appointed as chairman of
the Federal Reserve Board. A relatively stable currency has been the basis . . . for the economic
boom of recent years. . . .

And Volcker did it. In October 1979 he persuaded his colleagues to starve inflation of the dollars it
feeds on. President Reagan did little to help. In fact, his deficits worked against Volcker's efforts.
[29]

The conquering of inflation in a very short time was primarily a result of tightening monetary policy under Federal
Reserve Board chairman Paul Volcker. Volcker deserves high praise for the change in policy. But Reagan clearly
warrants a large part of the credit for endorsing the overdue correction in Federal Reserve policy from the
high-inflation 1970s. A major element of Reaganomics, in addition to the tax cuts, was sound money--a policy the
nation had not followed since the late 1960s. The Federal Reserve's policy of sweating out inflation took place with
the explicit approval of the Reagan administration, even though that policy contributed to the deep recession of
1981-82 and the unexpectedly large and immediate fall in inflation was a major factor in the budget deficit
explosion in the early 1980s.

The Reagan-Volcker anti-inflation policy may seem noncontroversial today, but it is noteworthy that at the time the
decisions were made, there was very little consensus about how to defeat inflation. [30] In 1980, for example,
economist Paul Samuelson wrote that "two-digit price inflation is a distinct possibility for much of the decade of the
1980s." [31]He predicted an inflation rate from 1982 to 1987 of 9.4 percent a year. The Democratic party was
endorsing a host of inflation-fighting measures that were economically wrongheaded and almost certain to fail.
During the 1980 Democratic presidential primaries, Jimmy Carter's anti-inflation policy included credit controls and
gas rationing while Ted Kennedy, his opponent, endorsed wage and price controls.

Most Keynesian economists had predicted that Reaganomics would make inflation worse, not better. Hobart
Rowen of the Washington Post stated the conventional wisdom by arguing that the Kemp-Roth tax cuts would be
"dangerously inflationary." [32] He added, "There is nothing in the [Reagan] fiscal program--in the view of those not
addicted to supply-side theory--that works against inflation." James Tobin, a Nobel prize winner and an informal
Clinton administration adviser, also had warned of the inflationary impact of Reagan's tax cuts and had called
instead for "a five-year period of gradually declining wage-increase guide-posts."[33] The late Walter Heller, a
Keynesian who had served as John Kennedy's chief economic adviser, summarized the conventional wisdom most
succinctly in 1980: "The [Reagan] tax cut would simply overwhelm our existing productive capacity with a tidal
wave of demand," thus accelerating inflation.[34]

Amazingly, even after inflation had fallen by more than half by late 1982, Reagan's skeptics believed the progress
on prices was a temporary aberration. Economist Paul Krugman, now of Massachusetts Institute of Technology,
and Larry Summers of the Clinton Treasury Department warned in November 1982 of a coming "inflation time
bomb." "It is reasonable to expect a significant reacceleration of inflation in the near future," they wrote. "A
significant portion of the slowing of consumer price inflation since 1980 does not represent a reduction in the
underlying rate." [35]

Fable 4: Reagan Had Little to Do with Ending the Energy Crisis; He Was the Fortunate Beneficiary of
the Demise of the Organization of Petroleum Exporting Countries

Luck was on Reagan's side in the 1980s. OPEC crumbled and world commodity prices fell.[36]

OPEC's demise clearly contributed to the end of high inflation in the 1980s. But luck is not what caused the
downfall of OPEC. Reagan's first official act as president was, by executive order, to immediately terminate oil
price controls, a policy that instantly reenergized America's domestic production and exploration of oil.

Moreover, the energy crisis in the 1970s was not purely a result of external factors beyond the control of
politicians. With respect to dealing with OPEC, virtually every government energy policy in the 1970s--those under
Nixon, Ford, and Carter-- exacerbated the energy crisis, from the windfall profits tax to energy price controls.
Reagan hastened the end of the energy crisis by repealing all of these misguided policies.[37]

The growth rate under Clinton has been 2.7 percent, half a percent below the 3.2 percent growth rate under
Reagan and a full percentage point below the 3.8 percent growth rate during the 1983-89 expansion. Standard
government forecasts predict a 2-2.5 percent growth rate through the end of the decade. Yet, if even the high end
of that forecast proves to be accurate, the 1990s will be the lowest economic growth decade since the Great
Depression and the second lowest in the 20th century.

Fable 6: The 1980s Expansion Was a Classic Keynesian Economic Recovery Driven by the Stimulative
Effects of High Deficits

Reagan's economic program actually amounted to the longest and most successful Keynesian
recovery the world has yet seen. [39]

If the 1980s expansion had been a classic, demand-driven Keynesian recovery, nominal demand should have
grown rapidly in the 1980s. However, as Figure 9 shows, over the course of the 1980s the rate of nominal demand
growth fell.

The Keynesian explanation of the economic recovery in the 1980s is also fundamentally inconsistent with the sharp
fall in inflation throughout that decade. If the recovery had been driven by a hike in the demand for goods and
services rather than by a supply-side effect of greater output, inflation would have risen rather than fallen. But it did
fall. This is why the near-universal predictions by Reagan's opponents from 1979 to 1981 of higher inflation from
tax cuts proved to be entirely misguided.

Finally, if budget deficits are highly stimulative, the post-Reagan period of 1990-95 should have produced strong
economic growth. The budget deficits of that period were very nearly of the same magnitude as the deficits of
1982-89 (4.2 percent of GDP versus 3.9 percent of GDP); in the 1980s, however, we had rapid growth and in
the 1990s we have had anemic growth. The answer seems to be the supply-side effects of tax and regulatory
reductions in the 1980s versus the tax hikes and reregulation in the 1990s.

Fable 7: The Robust Reagan Economic Expansion Was Only a Result of the Steep Economic Decline in
the Early 1980s

Reagan's political adversaries maintain that the economy expanded rapidly from 1983 to 1989 only because of the
underused resources from the severe recession of 1981-82. This interpretation of the 1980s expansion is
contradicted by two facts. First, even taking into account the deep recession years of 1981-82, the economy grew
at a faster rate over the entire Reagan period than it did over the Ford-Carter years and the Bush-Clinton years.

Second, the economic expansion of the 1980s was notable for not only its strength but also its length. Figure 10
demonstrates that the Reagan recovery lasted 92 months, making it the second longest uninterrupted economic
expansion in the century--outlasted only by the 1961-69 boom.[40]

Fable 8: Bush and Clinton Inherited a Future of High and Rising Deficits from Reagan

It is a popular misconception that Presidents Bush and Clinton inherited large deficits "baked in the cake" from
Reagan policies. When Reagan left the White House in January 1989, the fiscal outlook was expected to continue
to improve rather than worsen. In that month, the CBO released its long-term forecast for the economy and the
budget deficit.

Table 7 shows that the deficit was expected to continue to fall steadily to $110 billion and 1.5 percent of GDP by
1995.[42]These forecasts reflected in large part a continuation of the modest fiscal progress achieved during
Reagan's second term. The CBO concluded that continued deficit reduction would occur even if Bush were to do
nothing to improve the budget outlook and simply left fiscal policy on automatic pilot. In reality, the national debt
was $622 billion higher than anticipated and as a share of GDP, the budget deficits were nearly 2 percentage
points higher. Measured in real dollars, the 1990-94 period showed the worst five-year deficit performance in the
post-World War II era. [43]

Fable 9: Workers Had to Work Harder for Smaller Paychecks in the 1980s

Caught between the lawmakers in Washington and the dealmakers on Wall Street have been
millions of American workers forced to move from jobs that once paid $15 an hour into jobs that
now pay $7. [44]

Barlett and Steele never back up such anecdotal claims with any facts. Here they are: the correct way to measure
changes in worker pay from one period to the next is not by examining wages alone, but by tallying the total
compensation per hour--a measure that includes wages and benefits--paid to a worker. [45] Nonwage benefits
have been an increasing share of total hourly worker compensation. In 1960, 9 percent of worker compensation
was in the form of fringe benefits; in 1975, 16 percent of worker compensation was wage supplements; and by
1990, that percentage had risen to 20 percent. [46]So although it is true that average real wages have been falling
over the past 20 years, real compensation has been generally rising. The average real wage in 1990 dollars fell
from about $11.00 an hour in 1980 to about $10.00 in 1988, a 9 percent decline. But real compensation per hour
rose from $15.00 per hour in 1981 to $16.50 an hour in 1988. [47]

Fable 10: In the 1980s the Rich Got Richer and the Poor Got Poorer

During the 1980s the bucket of liberty and economic freedom rose, while the bucket of income
equality fell. Upper-tier Americans significantly expanded their share of national wealth, while
low-income citizens lost ground. Reagan policies were critical to the shift. [48]

During the Reagan years, the total share of national income tilted toward the wealthiest Americans. From 1980 to
1988 the wealthiest 5 percent of Americans increased their share of total income from 16.5 to 18.3 while the
poorest fifth saw their share fall from 4.2 to 3.8 percent. [49]

Yet it is not true that the gains by the wealthiest Americans came at the expense of low-income Americans. From
1981 to 1989, every income quintile--from the richest to the poorest--gained income according to the Census
Bureau economic data (see Figure 11). [50] The reason the wealthiest Americans saw their share of total income
rise is that they gained income at a faster pace than did the middle class and the poor. But Reaganomics did create
a rising tide that lifted nearly all boats.

Table 8 shows that by 1989 there were 5.9 million more Americans whose salaries exceeded $50,000 a year than
there were in 1981 (adjusting for inflation). Similarly, there were 2.5 million more Americans earning more than
$75,000 a year, an 83 percent increase. And the number of Americans earning less than $10,000 a year fell by 3.4
million workers.

Table 8
Workers' Incomes in the 1980s (millions of workers and billions of 1981 dollars)

Year

< $10,000

> $50,000

> $75,000

1981

66.0

9.9

3.0

1989

62.6

15.8

5.5

Difference

-3.4

5.9

2.5

% Change

-5%

60%

83%

Source: Cato Institute calculations based on Bureau of the Census, U.S. Statistical Abstract, 1996, p. 478, Table 740.
Note: Earning levels are adjusted for inflation between 1981 and 1989.

The gains in incomes of all income groups is all the more impressive when we examine data on income mobility.
Tens of millions of Americans moved up the income scale in the 1980s--an economic fact that is obscured when
only the static income quintile data from the start of the decade to the end are examined. Figure 12 shows that 86
percent of households that were in the poorest income quintile in 1980 had moved up the economic ladder to a
higher income quintile by 1990. Incredibly, a poor household in 1980 was more likely to have moved all the way
up to the richest income quintile by 1990 (15 percent) than to still be in the poorest quintile (14 percent).

Fable 11: The Poor and Minorities Lost Ground under Reagan's Economic Policies

The 1980s was the first decade since the 1930s in which large numbers of Americans actually
suffered a serious decline in living standard. [51]

The poorest 20 percent of Americans experienced a 6 percent gain in real income in the 1980s and have suffered a
3 percent loss in income in the 1990s. Figure 13, which compares the income trends for the poorest fifth of
Americans over the past 20 years, shows that the poor did the best during the Reagan years. Black Americans saw
their incomes grow at a slightly faster pace (11.0%) than whites (9.8%) in the Reagan years (see Table 9).

Table 9
Real Household Incomes

1973-81

1981-88

1988-94

Whites

-2.2%

9.8%

-3.8%

Blacks

-4.4%

11.0%

2.0%

Source: Bureau of the Census, "Money Income and Poverty Status in the United States, 1995," Current Population Reports
(Washington, D.C.: Bureau of the Census, 1995).

Fable 12: The Rich Saw Their Tax Bills Go Down in the 1980s While Everyone Else Paid More

Contrary to popular rhetoric, the wealthiest Americans did not pay less taxes; rather, they paid more taxes after the
income tax rate cuts in 1981. In constant dollars, the richest 10 percent of Americans paid $177 billion in federal
income taxes in 1980 but paid $237 billion in 1988. The remaining 90 percent of households paid $5 billion less in
income taxes over this period. [52] They earned more and they paid more. In fact, Federal Reserve Board member
Lawrence Lindsey has shown that taxes paid by the wealthy were substantially higher than they would have been if
the top tax rate had remained at 70 percent.[53] Figure 14 shows that the share of total income taxes paid by the
wealthiest 1 percent of all Americans actually rose from 18 percent in 1981 to 25 percent in 1990. The wealthiest
5 percent of Americans saw their tax share rise from 35 to 44 percent. So the rise in the deficit was clearly not a
result of "tax cuts for the rich."

Conclusion

The 1980s were years of economic progress, not decline. Real GDP grew by about one-third in the 1980s. The
economic gains were widely distributed among income groups, with every income quintile, from the richest fifth to
the poorest fifth, gaining ground in the Reagan years.

The Reagan tax cuts were not a primary cause

of the eruption of the deficit in the 1980s. The main two causes were an unexpectedly
sharp reduction in inflation in the early 1980s that led to large real increases
in federal spending, and a nearly $1 trillion military build-up during the last
phase of the cold war.

Most significantly, the economy of the 1980s outperformed that of the 1990s in virtually every measurable
category. Economic growth was higher, job creation was faster, incomes rose much faster, and productivity
climbed at a healthier pace.

Footnotes

[1]. The Economic Recovery and Tax Act of 1981 (the Kemp-Roth tax bill) reduced income tax rates by 25
percent over three years.

[2]. White House Press Release, Office of the Press Secretary, August 5, 1996. Remarks by the President at
signing ceremony for Iran-Libya Sanctions Act of 1996.

[3]. See, for example, Donald Barlett and James B. Steele, America: What Went Wrong? (Kansas City, Mo.:
Universal Press Syndicate, 1992), p. 3. The authors argue that "In the 1980s the already rich got richer than ever .
. . while life for the working class deteriorated, and those at the bottom were trapped."

[4]. See, for example, "Promises Made, Promises Kept," White House Office of Public Affairs, December 1988.

[5]. For a detailed description of the economic policies of the Reagan administration, see William Niskanen,
Reaganomics: An Insider's Account (New York: Oxford University Press, 1988).

[6]. For a good summary of the economy's performance during the expansion years 1983-89, see Robert Bartley,
The Seven Fat Years: And How to Do It Again (New York: Free Press, 1992), p. 2.

[9]. Most of the economic data are only available through 1995. Where we have more recent data that include
preliminary estimates for 1996, we include them.

[10]. Actually, the lame-duck Reagan administration released a fiscal 1990 budget in early January 1989, but the
Bush administration mostly ignored it.

[11]. To account for the fact that the 1990-95 period is shorter than the eight Reagan and eight pre-Reagan years,
all the economic variables are shown on an average annual basis.

[12]. On the no-policy-lag basis, however, productivity growth was highest in the Reagan years.

[13]. Richard McKenzie argues that this expansion was the equivalent of adding another California to the American
economy. See Richard B. McKenzie, What Went Right in the Nineteen Eighties (San Francisco: Pacific Research
Institute for Public Policy, 1993) p. 121.

[16]. Net national investment in the 1980s showed a similar pattern to that of savings: the net investment rate fell
from 10.5 percent in the 1960s to 5.3 percent in the 1980s to an all-time low of 3.8 percent in the 1990s. Yet,
according to the Department of Commerce's Bureau of Economic Analysis, net foreign investment in the United
States exploded from -$31 billion in 1980 to a high of $115 billion in 1987. Over the course of the Reagan years,
net foreign investment in the United States increased by nearly one-half trillion dollars. In the global marketplace,
lower tax rates tend to attract capital because the after-tax rate of return on capital investment rises as the tax rates
fall.

[26]. This is not to argue against the wisdom of a defense build-up in the early 1980s. Even the Carter
administration had called for large defense spending hikes in its last budget. Reagan increased defense spending
faster than Carter would have, but some large increase in military spending was no doubt inevitable given the
geopolitical situation in 1980 and the almost universally acknowledged inadequacy of America's military in those
years.

[27]. David Stockman, The Triumph of Politics: The Inside Story of the Reagan Revolution (New York: Avon
Books, 1987).

[35]. Paul Krugman and Larry Summers, "Inflation during the 1983 Recovery," U.S. Government Memorandum,
September 9, 1982. Significantly, Summers and Krugman are two of the most vocal opponents of the Dole tax cut
proposal.

[43]. What is unique about the big deficits in the 1990s is that, unlike the very high deficits of the Reagan years,
which corresponded with high and growing cold war expenditures, the Bush-Clinton deficits have occurred despite
a shrinking defense budget. Normally at the end of a war period, the deficit falls sharply or even turns into a surplus
as wartime expenditures fall. But as discussed earlier, under the Bush-Clinton administrations, reductions in
wartime expenditures have given way to large increases in the budgets of most all other civilian programs.